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Can information technology prevent the next financial meltdown?

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Remember last year when banks stopped lending to each other because they lost trust in one another? Trust requires transparency, which can be helped by technology.

Information technology may help prevent a repeat of the chaos that tore through the financial system over the last year. But how effective is technology at distinguishing toxic assets from the good ones? This requires an additional element -- transparency.

The U.S. House Financial Services Committee's Subcommittee on Oversight and Investigations just wrapped up hearings on the ways technology can be employed to improve TARP and financial services oversight.The hearings were largely focused on driving accountability and transparency through database technology.

Dilip Krishna, a specialist in risk and financial management for Teradata's financial services and insurance organization, testified that we already have the tools capable of surfacing toxic assets and other anomalies. It's a matter of political will -- both on the part of policymakers and business leaders -- to see these technologies through. "All around us, we see evidence that the proper use of technology can generate immensely valuable results while at the same time improving efficiency and reducing costs," he said. "Now is the time to apply technology to address this most important issue."

A vast amount of work has already been done with technology in finance. “Technology has advanced to the point where the oversight of large, complex financial enterprises is now feasible,” Krishna related. “In fact, large organizations around the globe routinely use technology for financial risk management. One of the key areas in this regard is in the management of risk data and analytics.”

For example, financial firms have been at the forefront of employing data and analytics to better manage risk. “Information technology makes it possible for companies to collect, merge and analyze very large amounts of customer data in real time to better and more efficiently serve their customers, leading to competitive advantage,” Krishna said. “Technology has also made it possible for financial firms to manage their risks effectively while managing substantial growth and consolidation in their business lines.”

Krishna also pointed out that these preventive solutions can be put into place today. “Analytics and visualization technologies have also advanced significantly so that complex calculations can be completed and presented extremely rapidly for quick response. In line with what may be expected of technology advances in general, not only are the capabilities improving at a tremendous rate, but costs are also dropping precipitously."

However, these systems were not enough to stem the recent economic crisis. All the technology in the world cannot help forestall a crisis if there is no transparency into data about the assets and operations of these financial firms. “Technology was not properly employed to deal with the types of toxic assets that caused these catastrophic losses,” Krishna testified.

Transparency is the key. What is needed to prevent future financial meltdowns, Krishna said, is greater transparency into the operations of financial institutions that doesn’t undermine consumer privacy.

Transparency enables trust, and trust is the glue that holds the financial system together. The financial crisis that deepened with the collapse of Lehman Brothers in September 2008 was created because banks stopped trusting each other. Who else had an unsustainable inventory of toxic assets such as bad mortgages? And thus, credit stopped flowing and the global financial system locked up.

By employing systems, processes, and technology that provides greater transparency, financial executives and regulators can more effectively monitor trouble spots in the financial world. And maintain trust.

Krishna adds that bulding greater transparency into our financial system doesn't have to be a huge, complex undertaking: "Examples of relative transparency are all around us. Every day financial analysts and ordinary investors rely on financial reports issued by companies. An even more practical example is the implicit belief we all have that the account statements we receive from our bank accurately reflect the balance of all our transactions."

Employing systems and processes and help provide greater data transparency is smart business, because decision makers and policymakers can manage events more proactively -- which is always far less costly than multi-billion-dollar bailouts later on.

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Joe McKendrick

Contributing Editor

Joe McKendrick is an independent analyst who tracks the impact of information technology on management and markets. He is a co-author of the SOA Manifesto and has written for Forbes, ZDNet and Database Trends & Applications. He holds a degree from Temple University. He is based in Pennsylvania. Follow him on Twitter. Disclosure